A Basically Bearish View

Chris Johnson of Schaeffer's Investment Research sees a market that continues to move lower, though he has a few picks in telecom and oil

"The stock market looks a little too precarious to me," says Chris Johnson, director of quantitative analysis for Schaeffer's Investment Research. Johnson describes himself as short-term bearish and adds that, longer term, "You're likely to see a market that continues to move lower, rather than higher."

Johnson bases his forecast on the technical factors he watches, as well as such fundamental forces as the difficulty he expects companies to face in continuing to keep earnings growing. He's also concerned about, among other things, the prevalence of optimism among investors, which he reads as a negative sign.

Looking at market sectors, Johnson sees telecom as the only area of technology that he advises investors to get into if they want tech in portfolios. And he predicts oil and oil services will continue to outperform.

These were a few of the points Johnson made in an investing chat presented Feb. 10 by BusinessWeek Online on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff and June Kim. Edited excerpts follow. AOL subscribers can find a full transcript at keyword: BW Talk.

Q: Chris, from where you sit how does the stock market look right now?


The stock market looks a little too precarious to me. As it stands right now, many of the indexes are trying to stick to levels above some of their key short-term moving averages, and therefore, like many traders in the market, I've adopted a wait-and-see attitude going through the next few weeks.

One example of a trend line I'm watching closely is that of the S&P 500 and its 50-day moving average. This trend line is well known to be one that intermediate traders and institutions keep their eye on -- and it normally induces some selling when the S&P 500 closes below it. And the last two days, [we have] seen daily lows that have bounced off this trend line. Add to the weakening technicals of the market some of the optimistic sentiment that we continue to see, and it makes me lean to the short-term bearish side, if you were to press me for an answer.

Q: What does your analysis forecast for the telecom sector? Interesting merger activity there.


As a matter of fact, one of my picks for 2005 (made in December) was AT&T (T ). This is one of the sectors [where] I've been telling individuals: If they have to have technology in their portfolio, they have to look in telecom.

As it stands, there's merger and acquisition activity going on right now, companies continue to expand as technology allows them, and consumer demand is high for their products, leaving the telecom industry as one of the few out there that's seeing true increases in demand.

Q: Your opinion, please, for the short and long term on ExxonMobil (XOM ) and ChevronTexaco (CVX ).


First of all, oil companies and oil-service companies are among the sectors that we see continuing to outperform the majority of the sectors on the Street, simply because of fundamental positives, technical positives (as these sectors continue to see positive price activity), and, of course, negative sentiment. The composite scores, according to our scoring system, have the oil sector at a 7 and the oil service sector at a 6.5, which is among the highest of the sector rankings for our scoring system.

Looking at the two companies -- first ChevronTexaco, with a score of 6. Chevron's put-call ratio is right in the middle of its one-year range, telling us that options traders are neither overly optimistic nor overly pessimistic toward the stock. Digging deeper, though, I see that the short-term and intermediate-term trends of this put-call ratio are to the downside, telling me that options traders are adding calls to their positions at a fairly good pace. While this isn't a warning sign, it's certainly something that I'll remain aware of as the stock continues to make new highs.

As it stands, 12 of the analysts covered by Zacks have the stock at a hold or lower, while only five are at a buy or higher, telling me that the analyst community continues to sit on the sidelines. But with new highs being made on the stock, the sentiment will likely switch, and we'll see analyst upgrades.

Of course, this means more buyers down the road. Given this, I expect that we'll see CVX continue to do what it has done today, in making new 52-week highs until we begin to see too much optimism, at which time the stock will likely top out.

Next stock: ExxonMobil, with a scorecard rank of 9. This stock is, of course, extremely attractive to us. The put-call ratio for ExxonMobil is among the highest readings over the last year, telling me that options investors continue to add puts to their portfolios, which means they're obviously growing in skepticism. While some may think that's bad, those who follow sentiment know that this is actually a good sign, as it tells us that there continues to be sideline cash available to move the stock higher.

Q: Will Procter & Gamble (PG ) be a good stock in the near future? And how will the recent merger with Gillette (G ) affect other consumer-product companies, such as Colgate-Palmolive (CL )?


Many are seeing the acquisition of Gillette as a positive for Procter & Gamble, but this is something that will take time to evolve. Given that, and our outlook based on sentiment and technicals for P&G, this is a stock that would be best categorized as a hold, rather than something that I would be adding to my position in.

It's interesting, because there has been a lot of media hype about the Procter & Gamble-Gillette merger, and very little about the SBC Communications (SBC )-AT&T combo. While it's true that there are likely to be regulatory hurdles in the latter, it looks to me like the better of the two when it comes to stocks I'd want to own after the dust settles.

Q: Chris, early on you said you were short-term bearish -- what's your stance looking further out?


Unfortunately, the stance doesn't improve as we look beyond the next few months. The bottom line for this market is that we continue to see some fundamental concerns, certainly some technical concerns, and investors who, while in the short term can swing to pessimistic sentiment, overall continue to remain optimistic toward the market.

From the beginning of this year, the market started with its face in a head wind, as the first year after a Presidential reelection is historically considerably weak for the market, as the Administration normally turns their attention toward "their" policy.

Add this to the fact that we believe it's going to be hard for companies to continue bottom-line earnings growth due to a number of factors (i.e. interest rates, corporate earnings not increasing), and you get the impression that companies are going to be left squeezing their current balance sheets for as much earnings growth as they can get -- the problem there being that they've just spent the last three years doing that same thing. The term "squeezing water out of a stone" comes to mind.

Given the Presidential cycle, the weak fundamental outlook, the continued optimism, and the weakened technicals of the market, we believe that you're likely to see a market that continues to move lower, rather than higher.

Q: What about an opinion on General Electric (GE )?


Looking at GE -- and many other large-cap stocks, for that matter -- we feel that the outlook is not much brighter than that we hold for the smaller-cap or mid-cap companies. For some time, the large-cap blue chips have been a defensive play as investors have moved out of some of the technology issues. Unfortunately, that has made for what we term a crowded trade for many of the blue-chip companies.

Let me give you an example of the sentiment that we see to back that up. As of today, the number of analysts who cover GE, according to Zacks, is 19 -- 16 of those analysts have a buy or strong buy on the stock. Looking at that even closer, 11 of those 16 have issued strong buys on the stock.

What that tells us is that the number of people who have purchased these stocks over the last six months is huge, and that makes for a very crowded investment. Normally, we look for situations that aren't crowded -- in other words, those investments or stocks which the public has not rushed in and bought, which means that we've got our money in, allowing the other investors who follow to move our investment higher.

With a stock like GE, which everybody has obviously bought, it leaves you asking, "Where's the next group of investors going to come from that are going to push the stock higher after I've taken my position?" Other stocks that would fit into this category are Microsoft (MSFT ) and Procter & Gamble.

One of the other aspects of a crowded trade is that if something should go wrong with the stock that investors don't expect, that crowd equates to more selling potential, which means the stock can see accelerated selling (again, if something should happen). I would classify GE as a hold right now.

Q: How much divergence is there now between technical and fundamental views of the market? Is it more or less than usual?


Actually, it seems to be somewhat in line. Except for very recent trading activity, the end of 2004 saw an expected technical move in stocks. Fundamentals were improving, you saw earnings improve, etc., etc., and you had the coattails of the Presidential election. So there were fundamentals driving prices higher in the end of 2004.

In 2005, thus far, we're seeing a situation in which the technicals are beginning to disconnect, as the market slides to slightly lower levels, despite the fact that for the most part the most key fundamental (earnings) has been positive. I think this reflects the fact that investors have become too optimistic and are beginning to put some questions on what the second half of 2005 will offer.

Thus, that optimism is beginning to turn a bit, which has induced some selling. This is why we have the recent disconnect between technicals and fundamentals.

Edited by Jack Dierdorff

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